Sheriff Yellen

It looks as though Janet Yellen will be soon be the new chairwoman of the Federal Reserve. As Ezra Klein explains, Democrats in the Senate objected to Larry Summers because they saw him as a friend to the financial industry, and they think the Obama administration’s approach to financial regulation is too lenient. Their strenuous objections to Summers amounted to little more than a feeble protest, since financial regulation would probably be similar under Summers’s leadership and under Yellen’s.

“The Left won a big symbolic victory by striking down the Summers nomination,” Tyler Cowen writes. “But it was precisely that — a symbolic victory.”

Yellen may not look like a friend of the financial industry, but, then again, she doesn’t have a reputation for antipathy toward the banks either. She did support the deregulatory, neoliberal policies of the Clinton administration. It’s hard to know just how vigilant she would be.

For evidence of just how troubled our system of financial regulation is, read Peter Henning’s analysis of the settlement between JPMorgan Chase and the Securities and Exchange Commission this week in the “London Whale” case. The agency has been trying to extract admissions of wrongdoing from banks that have allegedly committed fraud and other crimes. JPMorgan did offer an admission, but it was carefully worded to avoid further legal consequences. The commission was evidently satisfied with allowing the bank to stop short of admitting fraud, which would have made it easier for private investors to sue JPMorgan for any losses they might have suffered. Admissions of wrongdoing are important not only for their symbolic value. In this case, however, the government apparently felt it either lacked the evidence to take the bank to court, or perhaps regulators were afraid of the consequences of a trial for the economy in general.

The Dodd-Frank law contains provisions designed to make banks more stable, but it doesn’t ban banks over a certain size. Instead, the strategy would be to require banks and regulators to agree on a plan in case of a crisis for resolving unpayable debts. Maybe this strategy would succeed in containing a developing crisis, but it does not really address the problem of large banks’ bargaining power when they are negotiating cases of wrongdoing with regulators.

Making sure that wrongdoers are brought to justice and protecting public investors from malpractice at major institutions is important, but the case of the London Whale also shows why financial regulation can’t just be punitive and after the fact. Regulators also have to prevent bankers from engaging in self-destructive behavior in the first place, since apparently they are incapable of restraining themselves on their own. JPMorgan will pay $920 million to settle its case, but that’s not much compared to the $6 billion that it is estimated to have lost in the London trades. The same is true of the financial crisis. It isn’t as though the banking industry made money destroying the global financial system. The thought of collapse or of fines at some indefinite point in the future did not cause bankers to look carefully at what they were doing at the time. It remains to be seen to what degree Dodd-Frank will help regulators work with banks during normal times as an additional check against reckless behavior.